May 27, 2021
The Biden administration’s American Jobs Plan, which has a focus on traditional infrastructure, may provide an attractive opportunity for taxable municipal investors. The Plan, which we believe will likely be passed with bipartisan support, features a “Build America Bonds” (BAB) program similar to that of the 2009-2010 American Recovery and Reinvestment Act, which resulted in a significant increase in taxable municipal debt issuance and opportunity for investors. The Plan again includes the US Treasury providing a subsidy to issuers for having to pay higher interest costs on taxable municipal bonds, with the goal of increasing the investor base for the program.
In this insight, we provide an overview of the American Jobs Plan, scenarios for its approval, and options to pay for it. We compare the BAB-style initiatives of both the Obama and Biden administrations, focusing on the size and scope, sequestration and refunding proposals and implications for taxable municipals. We conclude that while there are still uncertainties on the size, scope, and timing of the Plan, we expect it will represent an opportunity for investors, with taxable municipals offering relative value advantages versus US credit and continued diversification benefits, especially for offshore investors, given current favorable hedging costs.
Biden’s infrastructure plan
The Biden administration is planning to pass two infrastructure packages – the American Jobs Plan and the American Families Plan – to add to the fiscal stimulus already enacted, designed to help restore economic growth, particularly to those states and localities most impacted by COVID-19. Of significance to the taxable municipal market and a focus in this piece is the American Jobs Plan, which represents $US2.25 trillion (though is subject to revisions), with approximately 60% of that amount focused on infrastructure, such as roads, bridges, tunnels, and airports.
The proposals are currently being addressed by legislators with market attention focused on how such legislation will be passed and how it will be financed.
For the American Jobs Plan, there appears to be enough bipartisan support to approve the package, as conceptually infrastructure is a known need. If a bipartisan deal cannot be achieved, the Biden administration will seek to approve it through the budget reconciliation process, which requires only 51 votes of the US Senate. This involves all Democratic senators voting in favor, with the vice president as the deciding vote. At least one Democratic senator has expressed the desire to strike a deal in a bipartisan fashion and not utilize reconciliation. This backdrop makes the ultimate outcome on feasibility, timing, and size difficult to predict; however, our base case is that the plan passes with bipartisan support.
We turn to the more difficult question, “How do we pay for it?” This outcome is less transparent at this point; however, the one method that seems certain is higher taxes. This has played a role in the record inflows that tax-exempt bond funds and exchange-traded funds (ETFs) have seen this year, as higher taxes increased the value proposition of tax-free municipal bonds.
Considerations for the taxable municipal market
A number of factors of the American Jobs Plan could impact the taxable municipal market, and combined these may result in an opportunity for investors globally, in our view. Specifically, there is a component to the plan that includes a Build America Bonds (BAB)-type program, which was part of the American Recovery and Reinvestment Act signed by the Obama administration in 2009, to incentivize states to invest in infrastructure at a subsidized cost. While the details are subject to change, the latest iteration under President Biden’s plan would provide municipal issuers with the opportunity to sell taxable debt and receive an offsetting subsidy by the federal government at a projected rate of 28%. (There are two separate standalone infrastructure bills in Congress, one of which proposes subsidies at 42% for a period and then declining to 38%, 34%, and 30%. However, we don’t believe either bill will pass.)
Comparing the 2009-2010 BAB program with the current proposal we note the following:
- Greater scope and uptake in the program
The 2009-2010 program was limited to general obligation and essential service revenue issues, whereas all sectors will be eligible to participate under the current plan’s proposal.
In addition, in 2009-2010 there was reluctance from some state and local governments to issue debt even with the subsidy, due to the possible negative impact on their credit rating or an unwillingness to increase to their existing debt profiles, which resulted in lower-than-expected issuance out of the BAB program. During the COVID-19 crisis, states have managed their economies differently and have not necessarily been equally impacted, which has resulted in varying economic performance. This may result in the most negatively impacted states having a greater willingness to partake in the program.
Combined, these factors could potentially allow the program to be significantly bigger than the prior program, a benefit to investors with greater supply of taxable municipal bonds.
Sequestration is a congressional policy that subjects spending to across-the-board cuts when an agreement on a deficit-reducing budget cannot be achieved by a specified date. The American Jobs Plan program will eliminate being subject to sequestration (it was featured in the 2009-2010 plan, which saw subsidies fall on a few occasions), which was a concern for some investors because of the potential for the subsidy to be lowered under certain conditions. This will make taxable municipal debt more attractive as the subsidy is guaranteed for the life of the bond.
Advance refundings occur when a municipal debt issuer is able to sell a new issue at a significant cost savings, specifically to retire an existing higher-cost debt issue in the market, on a future optional call date. There is speculation that this provision in the tax-exempt market may be restored after being eliminated during the Trump administration. If this were to occur, the current relative value of tax-exempts would shift supply from the taxable market back to the tax-exempt market as it would be less expensive for issuers to raise debt. If left out, the current rules do incentivize issuers to refinance debt in the taxable market when economically feasible.
The outcome of this component of the legislation is unknown at this point, but will have an impact on the market in some form.
Whatever the ultimate size of the program, we believe it will represent an opportunity for investors, with taxable municipals offering relative value advantages versus US credit and continued diversification benefits.
While we do not expect the type of spread movement experienced during the 2009-2010 BAB era, there will still be an opportunity for high quality, steady cash flow, duration, and a better risk-adjusted return at more attractive spreads than are currently available, assuming US Treasury rates stay in the current range.
An additional consideration for ex-US investors is hedging costs. Flows from Asian and European investors have accelerated over the past several quarters as currency hedging costs have come down significantly. The net effect on the relative value of US taxable municipals on a hedged basis has increased their attractiveness. If current hedging costs stay near current ranges when an infrastructure program commences, this is quite likely to result in a greater relative value opportunity for investors.